What Spotify’s Financials Tell Us About Streaming Audio Economics – Part 2

Yesterday, we explored the numbers behind Spotify’s tremendous growth in subscription and advertising revenue counterbalanced by its shrinking gross margins. Today, we will discuss where all of that money is going.

Who is Getting the Money?

Spotify is losing money and yet music label executives are continually demanding more. XAPPmedia conducted an analysis earlier this year that showed music labels are taking 51% of all streaming revenue and reserving only 19% for artists. In that analysis we estimated streaming services such as Spotify were retaining 30% of revenue. Apparently that was an overestimation.

Mark Mulligan’s analysis shows that 83% of Spotify’s revenue was consumed by royalties in 2015. That means they are only retaining 17% of the total and we underestimated the current value grab by labels. Based on other industry data we can surmise that 61% of all revenue is retained by the labels while 22% goes to songwriters, publishers and performers. In this instance it appears that labels are keeping 3.6 times more revenue than Spotify and 6.6 times more than recording artists. Music label executives like to complain about a value gap in the industry, but data show they are filling it.

So why does Spotify have to pay so much more than 70% of revenue? Mulligan points out three components.

Some of it comes down to covering the cost of those $0.99 cent promotion deals. Spotify covers most of the cost of the lost revenue.

In addition, music labels demand pre-payments based on estimated volume which means they receive revenue even if the streaming service users don’t choose that label’s music at the expected rate.

Finally, publishers have been demanding upwards of 15% in their own rights fees. All of these factors are conspiring to squeeze Spotify’s margins.

A Great Global Growth Story

One thing is clear, Spotify is a great story that highlights the global growth of music streaming services. Revenue is up sharply from both subscriptions and advertising and that has paralleled a rapid rise in the monthly active users. It is also clear that the current economics are challenging. Music labels have made a living off of squeezing artists on one end and distribution on the other. It is not clear that either can sustain much more of a squeeze.

Improving Monetization

Spotify and other streaming services can improve their economics today by capturing higher ad rates even if they cannot get better terms from music labels. Yesterday we pointed out that Spotify could have earned up to another $140 million in advertising revenue if it didn’t reserve so much of its ad inventory for internal promotions of its subscription service. That would drive ad revenue by freeing up saleable ad inventory, but that analysis didn’t account for higher ad rates. If Spotify were to sell more premium ad formats like interactive audio ads, that ad revenue could contribute as much as $290 million more advertising revenue when combined with expanded ad inventory.

We know from Nielsen data that 95% of U.S. listeners have chosen ad-supported listening. Once the market for subscribers is tapped out, improved ad monetization will be the primary path to higher revenue and better margins.